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Leading the pack: Another view of price leadership
✓ Natural Monopoly: Natural monopolies exist due to economies of scale.
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As the consequence of the economies of scale, the monopoly provides the commodity at much lower cost per unit than potential entrants, discouraging new firms from establishing themselves in the market.
Electric companies are an example of a natural monopoly. ✓ Legal Monopoly: Legal monopolies exist due to government legislation and protection. Typically, legal monopolies are privately-owned companies that are granted a monopoly by the government. The legal monopoly is established to protect consumers’ interests. An example of a legal monopoly is local cable television service. In this situation, a local government grants a monopoly in order to eliminate unnecessary duplication of costs that leads to higher prices for customers. For example, two cable television companies have to lay twice as much cable, construct two transmission facilities, and so on. The consequence is a doubling in cost. In addition, these two companies would split the market, resulting in each company serving half as many customers as a monopolist. The inevitable result is higher prices for consumers. ✓ Government Monopoly: A government monopoly is a monopoly that’s owned and operated by government. The primary difference between a government monopoly and a legal monopoly is that the government monopoly is publicly owned while the legal monopoly is privately owned. Examples of government monopolies include garbage collection in some cities and public water companies. ✓ Patent Monopoly: Protection of an invention under the patent laws results in a patent monopoly. This protection’s purpose is to encourage research and development by ensuring a period of time over which the potential for monopoly profit exists. Such protection, however, is temporary; therefore, patent monopolies have a limited lifespan as a monopoly. Examples of patent monopolies are numerous, ranging from
Xerox’s patents on components of copying technology to Lego’s patent on the interlocking feature of plastic toy building blocks. ✓ Resource Monopoly: A single firm’s virtual control of an entire resource’s supply results in a resource monopoly. The best current example of a resource monopoly is De Beers’s control of diamonds.
Enjoying the long run
Because of barriers to entry, monopolies are able to maintain positive economic profit in the long run. Therefore, the conditions of the short-run equilibrium that I describe in previous sections also describe the long-run equilibrium with one caveat. In order to stay in business in the long run, the monopoly must earn at least zero economic profit.
Chapter 10: Monopoly: Decision-Making Without Rivals
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Polaroid and bankruptcy
If you have substantial profits in the long run, other firms try to offer similar substitutes in order to receive some of those profits. For example, you may remember Polaroid. Polaroid had a patent monopoly on instant-developing film. Introduced in 1948, instant-developing film and the camera it required were Polaroid’s flagship products for over half a century. Because of the great profits Polaroid received, however, other companies started developing substitutes. One result of this innovative process is the digital camera that allows you to even take pictures with your phone. Who needs instant-developing film now? Evidently, Polaroid thought the answer was nobody. In October 2001, Polaroid filed for Chapter 11 bankruptcy, and the reorganized company stopped producing the camera in 2007 and the film in 2009.
Zero economic profit is the same as a normal rate of return. As the monopoly’s owner, you’re receiving exactly as much income as you would in your next-best alternative. Zero profit doesn’t mean zero income.
Producing with Multiple Facilities
Monopolists, as is the case for many other firms, often produce their product in more than one factory. In order to maximize profits, the monopolist must determine how to allocate production among these factories. In determining this allocation, the monopolist’s goal is to produce additional units at the lowest cost. Therefore, the monopolist produces additional units of the product in the factory that has the lowest marginal cost. As a result, the monopolist minimizes the total cost of producing the total amount of the product.
Getting each facility’s best
If the marginal cost of producing an additional unit of output in one factory is higher than the marginal cost of producing the additional unit of output in a second factory, you’re not minimizing total production costs. Your total costs are lower if you switch production from the factory with the higher marginal cost to the factory with the lower marginal cost.
Cost minimization requires that the marginal cost of the last unit produced in each factory is equal for all factories. Figure 10-5 illustrates cost minimization
for a monopoly with two factories. The marginal cost curve in the far right diagram labeled ΣMC is the horizontal summation of the marginal cost curves for each factory. Figure 10-5 shows two factories, A and B. Thus, marginal cost equals MC* is associated with the output level qA1 in factory A and the output level qB2 in factory B. For the monopoly, it produces the output level q * at a marginal cost MC*. The output q * simply is the horizontal summation of the quantities each factory produces given MC* , or
Figure 10-5: Producing with multiple facilities.
Note in Figure 10-5 the monopolist wants to produce the output level q * and charge the price P* in order to maximize profits, because marginal revenue, MR, equals marginal cost, MC, in the far right diagram. In order to minimize the cost of producing q *, the monopolist must produce the output level in each factory that corresponds to MC*. Thus, q1 units are produced in factory A and q2 units are produced in factory B.
Calculating the best allocation with calculus
Calculus precisely determines the amount of output to produce in each factory — something that is difficult to determine graphically. Profitmaximizing production with multiple factories requires the satisfaction of the following equation
In other words, profit maximization requires that the monopolist’s overall marginal revenue, MR, equals the marginal cost of production at each of its factories — factory A, factory B, and out to factory I — however many factories there are.
Chapter 10: Monopoly: Decision-Making Without Rivals
Assume the following equations describe a monopolist’s demand, total revenue, and marginal revenue curves:
The firm has two factories. Factory A’s total cost and marginal cost equations are
Factory B’s total cost and marginal cost equations are
As indicated, profit-maximization requires
By solving this set of equations simultaneously, the monopolist’s profitmaximizing quantity of output is determined, as well as the quantity of output that’s produced in each factory.
